Spicing up rational thinking with emotions
Behavioral Game Theory and Its Applications
Game theory has a lot of applications in different aspects of life such as finance, programming, economic competition, and loads more, but the predictions in these fields are based on the assumption that all people behave rationally. But what happens in reality? Do people not succumb to their feelings and emotions? Do we not have virtues like equality, fairness or revenge which suggest ways apart from the rational one?
Yes, we do. There are instances in real life where the rational or the optimal way ceases to make sense to our human self. And these are the cases where behavioral game theory proves beneficial. Major limitations of game theory such as the assumption that all players are rational decision makers and have full knowledge about the rules of the game and its consequences have been solved by taking behavioral game theory into consideration.
Behavioral game theory aims to predict how people behave by incorporating psychological elements into decisions. It is a branch that uses psychological regularity to suggest ways to weaken rational assumptions.
For better understanding let’s look at a few experiments conducted to demonstrate how behavioral game theory can explain people’s behavior by including how they feel about the payoffs other people receive rather than their own, in contrast to how a rational person would only think of the payoffs they have received and try to maximize their profit alone.
- Bargaining/Ultimatum Game
Simple bargaining games like the ultimatum game have proved to be useful tools for bringing out issues of social utility. In an ultimatum game, a Proposer and a Responder bargain over an amount of money, say $10. The Proposer offers a division of the money, say X, to a Responder who can either accept or reject it.
If in case the Responder accepts the money(X) then the Proposer is left with 10-X for itself. In the case that the Responder refuses the trade then both of them are left with nothing. The $10 represents the gain of exchange and negotiation or the value that would be lost if the trade wasn’t made.
The ultimatum game is a method for asking the Responders, “Is this offer fair?” It forces them to put their money on the table or reject offers they claim are unfair. Studies of these games establish that people dislike being treated unfairly, and reject offers of less than 20% of the main sum ($10 in our case) about half the time, even though they end up receiving nothing. Proposers seem to anticipate this behavior, and to reduce the risk of rejection, they typically offer 40–50% of the main sum.
2. The Framing Effect
Rational players perceive a game and themselves clearly and consistently. However, when framing effects are important, players see the game differently according to how it is described. Framing effect basically means “description variance”. A framing effect occurs when a difference in description causes behavior to vary.
Below is a classroom demonstration based on Kahneman and Tversky’s experiments illustrating the framing effect which shows that people are more likely to take risks when outcomes are described as losses than when the same outcomes are described as gains.
Problem 1: We have to choose between-
Option A: A coin toss with 50% chance of getting $3,000 and 50% chance of getting nothing [35% subjects chose this option]
Option B: Get $1,500 for sure [65% subjects chose this option]
Problem 2: Given $3,000 in advance. We have to choose between-
Option A: A coin toss with 50% chance of losing $3,000, 50% chance of losing nothing [72% of the subjects chose this option]
Option B: Lose $1,500 for sure [28% of the subjects chose this option]
We can easily notice that Option A and Option B in both problems are functionally identical to each other but one option is preferred over the other. The difference in choice patterns is explained by loss aversion. In Problem 2, the framing of Option B makes it a certain loss, which is aversive to subjects. The attractiveness derived from the possible gain is not high enough to compensate for the aversion of the possible loss.
This is where the framing effect comes into play since the behavior of the subjects changed depending on the difference provided in the description. Players are more willing to risk disagreement when bargaining over possible losses than when bargaining over possible gains.
Now you’ve got a glimpse of the extensive branch of behavioral game theory. This department of game theory aims to replace the answers provided by traditional game theory, which assumes the fact that all players are capable of rational and strategic thinking, with more psychologically reasonable explanations.
In both the examples above we had seen how the players, rather than focusing on their payoff alone (as a rational player would), seem to respond in terms related to social acceptance, showing concerns about fairness and the perceived intentions of other players.
The second example majorly focuses on choice and judgment, the cases in which players respond to differences in how the game is described, rather than to the outcomes. For determining the end results of such cases behavioral game theory serves as an extensive tool.
So the next time you make a decision take into consideration the fact that better results can be produced if the behavior of a person is taken into account, i.e. not every person thinks rationally. These weakened rational explanations can be exploited by using psychological understanding, hence behavioral game theory is the way to go!
References:
- Askari, Gholamreza. “The Behavioral Model and Game Theory.” Available at The behavioral model and game theory | Humanities and Social Sciences Communications
- Camerer, Colin F. “Progress in Behavioral Game Theory.” Available at Progress in Behavioral Game Theory
- Camerer, Colin F. “Behavioral Game Theory: Experiments in Strategic Interaction.” Available at Behavioral Game Theory: Experiments in Strategic Interaction
- Gächter, Simon. “Blackwell Handbook of Judgment and Decision Making.” Available at Blackwell Handbook of Judgment and Decision Making
